Why I just switched from RBOT to ROBO
look beneath the hood....
First up, this is not investment advice, these notes are for information and hopefully sometimes entertainment purposes only. Please do your own research and always speak to a financial advisor.
In our multi theme portfolios (both managed accounts and in the UCITS strategy we run with Toscafund*) one of the longest and most stable positions has been in the I- Shares Robotics and Automation fund (RBOT) since we see this as an enduring long term thematic. However, we have just switched it to a different ETF, the L&G fund, ROBO and the reason for writing this is that the reasons for doing it reflect some important conflicts within markets and within ETFs themselves.
Concentration Risk
When we invest thematically, we use baskets (currently in the form of ETFs) in order to diversify our stock specific risk. As such, we are uncomfortable when any potential ETF has too concentrated a composition. In this space for example, we avoided the Global X Robotics and AI ETF, BOTZ, where the top 5 holdings are over 44% of the fund and the largest (inevitably) is NVIDIA, at 13%.
This is not to make a judgement on the weight per se, rather that we prefer less concentration risk - a point obviously being made in indices generally with the concentration from the Mega Tech stocks. We also capture stocks like Nvidia in exposure to other tech themes.
In the case of the I-Shares Robotics ETF however, no single stock was more than 5%. For example, Intuitive Surgical, the Robotic surgery company that I know well, as I used to own it as a single stock in an early Global Thematic fund and which was a ‘poster child’ component of the Axa Framlington Robotics and Automation Fund back in 2015, is ‘only’ 2.6% weighted in RBOT, compared to being over 10% of the BOTZ ETF.
Stock Specific Risk
However, the key reason for switching out of RBOT is not that a single stock is now over 5%, it is WHICH stock is over 5%. That stock is MicroStrategy.
Ironically, the Stock Robots that automatically allocate by market cap are buying a stock for a Robotics themed fund without reference to valuation and the fact that it doesn’t actually make money from robotics
This raises multiple issues: first, that the biggest stock in the Robotics and Automation ETF is not a Robotics or an Automation company. Second. that because the index is weighted by market cap, the extreme price behavior of this stock price means that the stock robots that run the strategy are automatically buying more of the stock, the more the share price goes up. The dopamine hit of the largest stock in your portfolio gapping up is actually a red flag, since you are significantly skewing the risk in your portfolio.
Which brings us to the third issue, stock specific risk. The reason that the share price of MicroStrategy has gone parabolic is a function of leverage on top of leverage. On top of leverage. On Bitcoin.
When that stock is going hyperbolic due to triple layers of leverage, the style drift becomes enormous and the risk escalates
For those that haven’t been watching the story of Microstrategy closely, there are a couple of excellent summaries here and here, but the TLDR is basically that the company is issuing debt in the form of convertibles and buying bitcoin and its holdings of 331,000 bitcoin means it assets are basically now around $31bn. It’s market cap however, is almost 3x that at $84bn. It is risky enough that the biggest component of our current Robotics ETF is a company that is on a PE of 240x and is trading at 3x its book, but as the links point out, there are also leveraged ETFs the exist solely to trade the stock.
Microstrategy was the most traded stock in the US this week. Number 5 and 8 in the Top 10 list were two double leveraged ETFs that trade….Microstrategy shares.
And if that wasn’t risky enough, there are options on those ETFs. So leverage, on leverage on a stock that is essentially leverage on Crypto. So nothing to worry about……..
Bottom line we like using ETFs as a vehicle to trade thematic baskets, giving us exposure to long term investment themes without taking stock specific risk and reducing the need to have a view on countries or broad economic sectors.
We dynamically allocate between them using a confidence score based on expected risk and return, so when we see a sharp increase in risk appearing we need to check our allocation. Importantly, our risk monitors pick up when things are doing well as well as when they are doing badly.
In this case, primarily due to the extreme performance of a single stock which has had outsized influence on the diversified Robotics basket, we are switching out of a whole position rather than simply tactically adjusting. This is due to the quantitative methods used to create an ETF being compromised by the characteristics of this particular stock meaning we need to change our allocation.
For more details on the Multi Thematic Fund, please contact HK@toscafund.com